Still Marching to Purcell's Drumbeat

June 15, 2005

By Emily Thornton Who's to blame for the turmoil at Morgan Stanley (MWD)? Is it Chairman and CEO Philip Purcell, who triggered a mass exodus of top bankers and traders with his controversial management shakeup? Or was it the board, which uncritically endorsed Purcell's plan? If you have trouble answering the question, there's a good reason: Purcell and the board are so intertwined as to be indistinguishable.

Even after Purcell announced his retirement on June 13, he continued to play a familiar role: speaking for himself, the company, and the board. True, two board members showed up when Purcell addressed Morgan Stanley employees. But not a single member participated in Purcell's public conference call.

ABSENCE SPEAKS. In response to a question from a research analyst, Purcell held forth on why the board was automatically ruling out as a replacement former President John Mack as well as other recently departed execs. Never mind the years of infighting in which Purcell's actions and decisions led directly to Mack and many others leaving; the soon-to-be ex-CEO simply suggested the board decided "they don't make the cut."

Where was the board on this critical question? Hiding in Purcell's shadow, as usual, even as he had one foot out the door. "It's a statement of how passive this board is that no board member was on the conference call," notes Jeffrey A. Sonenfeld, corporate-governance expert at the Yale School of Management. "A time of crisis is when it's a lot better to have an independent, separate voice speaking for the board when they're speaking about the CEO."

Echoes Jay W. Lorsch, corporate-governance expert at Harvard Business School: "The board is still trying to protect Purcell's feelings." Through a company spokesman, the board and Purcell declined to comment for this story.

MORE DEFECTIONS? Such unflinching loyalty, though, is sorely misplaced. The most vital question now facing Morgan Stanley is whether the board can chart a more independent path as it faces the crucial tasks of searching for a new CEO and putting an end to the damage done to the bank by the long fight. Allowing Purcell to stick around for up to nine months -- if a new CEO isn't found before the March, 2006 annual meeting -- certainly complicates the task.

The board has also handicapped itself with its refusal to consider any of the talented senior people who have left Morgan Stanley. Says Richard Stein, senior partner at executive search firm Korn/Ferry International (KFY): "Some of the most capable people are the ones who have already been ruled out."

If a successor isn't found rapidly, the price will be steep. Every day the search goes on, the firm risks losing more of its highly profitable traders and bankers, as well as clients. Uncertainty over Morgan's future in retail brokerage and asset management -- at the core of the management fight -- will continue. And although the brain drain could stop once a successor is selected, a bad pick could set off another wave of defections.

SHAREHOLDERS FORGOTTEN. Can a group of such experienced and intelligent people on Morgan Stanley's board do a more effective job? Only if they change their stripes. All too often in the past, they have relied too heavily on information from Purcell to reach important decisions. In 2001, the board wouldn't even listen to then-chairman emeritus Richard Fisher when he asked to speak on behalf of then-president Mack, who was quitting because of a dispute with Purcell. More recently, some directors agreed only very late -- and reluctantly -- to listen to the group of eight former Morgan execs as concerns about Purcell's leadership mounted.

In part, that reluctance stems from the board's makeup. Many board members have been close to Purcell for a decade. With the exception of Laura D'Andrea Tyson, all of the directors who originally came from Morgan Stanley when it merged with Purcell's Dean Witter, Discover & Co. have decamped, while Purcell has brought in even more loyalists. Last December, for instance, his 72-year-old former boss at Sears, Roebuck & Co. (SHLD), Edward Brennan, rejoined the board. In April, he appointed his two co-presidents, Zoe Cruz and Stephen Crawford.

"This board was slavish to the interests of a man as opposed to the interests of shareholders," says Samuel L. Hayes III, professor emeritus of investment banking at Harvard Business School. "They didn't get it that the leadership is failing."

LOST TALENT? Now, some change is coming. Directors have begun talking more with investors, and Miles Marsh was named head director in the wake of Purcell's announcement. Still, that the board has been forced by the fight to turn to an outside search -- despite naming two co-presidents -- also shows it is struggling with one of its key jobs -- to groom successors.

Wall Street firms rarely resort to hiring a headhunter to find a new CEO. "If they don't have a credible internal candidate, what have they been doing with themselves?" asks Nell Minow, head of The Corporate Library. The answer, unfortunately, is that in backing Purcell so fiercely, the board let credible candidates walk out the door. Thornton is an associate editor for BusinessWeek